Imagine a country that grows its economy by greatly devaluing against the reserve currency to develop a strong export sector. As the country becomes a major world power, it accumulates massive amounts of the reserve currency, and fears grow that its actions could destabilize global markets.
If you think that description sounds like China today, you're right. But it also describes France in the 1920s. Lessons from that era are instructive for those seeking to forecast China’s long-term position in the world.
France faded and never regained the stature that it achieved in the 1920s. I’ll discuss whether China is headed toward a similar outcome. First, however, let’s look at the striking parallels between the two countries, including currency pegs, reserve accumulation and urbanization.
Currency-fueled export growth
Both China today and France in the 1920s devalued their currencies and later maintained a peg to the reserve currency – dollars and sterling, respectively. These actions created a global market for their exports.
When a currency is pegged, it does not trade freely on international markets. The foreign exchange rate of the pegged currency is fixed because its availability to settle transactions is very tightly regulated. James Rickards, author of Currency Wars: The Making of the Next Global Crisis, explains that for China, “The surest way to rapid, massive job creation was to become an export powerhouse. The currency peg was the means to this end.”
France employed this strategy to gain status globally in the 1920s, as an abundance of young men were returning from the war.It positioned itself to bolster its export sector in 1922 with currency devaluations. But within four years, the depreciation that drove its trade became too problematic, promptingPrime Minister Raymond Poincaré to step in and stabilize the franc. In an effort to address the domestic problems provoked by the weak currency and sustain growth in the export sector, the franc was pegged to the world reserve currency, the sterling.